By Mike Jones

It was a bumpy ride in the NZD last week. After rising above 0.7150 early in the week, NZD/USD later succumbed to rising European credit fears, and finished the week closer to 0.7000.

Last week's local news was relatively unexciting. Data developments were a little mixed, with Friday's surprisingly good trade balance offset to some extent by an unexpected drop in December's building permits.

Meanwhile, the RBNZ's January OCR review was admirably boring and commendably short.

As widely expected, Governor Alan Bollard stuck fast to December's script (while keeping the OCR at 2.50%, for the record).

As such, it was really offshore factors that set the direction for the NZD last week. News China is beginning to clamp down on excessive credit growth raised fears a slowing in Chinese growth could derail the global recovery. And an escalation of the fiscal crises in Spain, Portugal and particularly Greece reinforced wider credit concerns for the European region, knocking investors' risk appetite for six.

Our index of risk appetite (which has a scale of 0-100%) fell to 48%, from above 58% at the start of January.

Not surprisingly, sovereign debt fears hit EUR the hardest last week; EUR/USD fell to 6-month lows below 1.3900. But NZD/USD didn't escape unscathed. The combination of lower risk appetite and "˜safe-haven' support for the USD saw NZD/USD fall 1.2% to nearly 0.7000.
It's worth noting though, that on a trade-weighted basis, the NZD finished the week pretty much unchanged. Most obviously, NZD/EUR found clear support from the weakening EUR. Meanwhile, creeping uncertainty about the likelihood of another 25bps hike from the RBA on Tuesday ensured any losses in NZD/AUD were limited to 0.7850.

Thursday's Q4 Household Labour Force Survey will be the highlight of the week data wise. While December's Monetary Policy Statement estimated this to show a 6.6% jobless rate, from 6.5%, we are looking for a clear jump, to 6.9%, based on a 0.3% fall in employment.

Ahead of this, Tuesday's Q4 Labour Cost Indexes and Quarterly Employment Survey should confirm weaker wage growth, while the latter will also have employment insights in its filled-jobs series.

We continue to believe the NZD will remain on a solid footing over the first half of this year. However, while heightened credit fears and worries about the global outlook continue to hang over markets, we suspect the NZD/USD will struggle towards 0.7150 this week. Initial support is seen towards December's low of 0.6970. A convincing break through this level would pave the way for a deeper correction.

The major currencies

The USD strengthened against most of the majors currencies on Friday night. On a trade weighted basis, the USD finished the week up 1.5%.
US data released on Friday was unambiguously strong. Fourth quarter GDP growth came in at a whopping 5.7% (annualised), the fastest pace in 6 years and well above the 4.8% expected. Similarly, the December Chicago PMI index soared to 61.5 (57.2 expected), a level last seen in late 2005. The University of Michigan consumer confidence survey for January also positively surprised (74.4 vs. 73.0 expected) completing a trifecta of good news.

While concerns about a slowing in US growth in 2010 remain, the data tended to reinforce expectations the Fed will begin tightening ahead of the ECB and BoE, providing support for the USD.

A further weakening in risk appetite also underpinned the USD on Friday. US equities got off to a flying start following the strong US data, before European credit woes again provided a drag. The S&P500 finished the night down about 1%, to register a 1.6% fall for the week.

Sovereign debt worries in Greece, Portugal and Spain continue to hang over the EUR and provide "˜safe-haven' support to the USD and JPY.

On Friday, EU Monetary Affairs Commissioner Joaquin Almunia said a bailout for Greece "is not possible and will not exist". As a result, EUR/USD plumbed fresh 6-month lows of nearly 1.3860. A slight increase in the December Eurozone unemployment rate (to 10.0%) only added to the pressure on EUR. However, rumours the Swiss National Bank was buying EUR/CHF (after it reached 10-month lows around 1.4640) helped limit the damage.

After an encouraging start to the year, sentiment and risk appetite have taken a clear turn for the worse in recent weeks. We suspect the precondition for a recovery in risk appetite and "˜growth-sensitive' currencies will be a stabilisation in the debt crisis in Greece (and to a lesser extent Spain and Portugal). In the absence of such, we're likely to see further modest gains in the USD this week.

There is also a string of event risk to watch for, which may provide a reminder to investors the global outlook for 2010 is not that bad. Central bank announcements from the RBA, BoE and ECB are due, with the Greek situation providing scope for a more interesting than normal ECB press conference.

On the data front, US non-farm payrolls on Friday will be the most closely watched. But European manufacturing PMIs, the US ISM non-manufacturing index and retail sales for Australia and Europe will also garner attention.

* Mike Jones is a BNZ Currency Strategist. All of the research produced by the BNZ Capital team of economists is available here.